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- Understanding risk versus return
Understanding risk versus return
What is the relationship between risk and return?
Investing starts with an assessment of the potential return against the risk we take. Agree that risking 1000$ to earn 100$ is quite a strange idea.
Risk in this case is the probability that the actual investment return will be different from the expected one. Therefore, before making any investment, you need to clearly understand what you risk and for what.
Let's say you bought Tesla shares and they fell 20%. What effect will this have on you and your financial situation? Answering this question is a must before any investment.
OK, but what do we get in return?
Investment income can be roughly divided into two types:
Interest - dividends, bank deposits, rents;
Capital gains - selling an asset at a higher price than it was purchased;
So basically by making any investment, we expect to receive something in return, whether this is dividends from stocks, bonds interest, or appreciation of real estate value.
Remember, the higher our expected return, the higher the risk.